Super Tuesday is upon us and we STILL may not know the winners – the race between the candidates is close. Yesterday the market retreated and gave up the several day rally. The tech sector continues to see the largest volatility and the MSFT / YHOO / GOOG is sure to keep high volatility at play in this sector. The NDX will probably be feeling it more than the broader based indices – so expect a wider trading range. GOOG broke down through $500 and the contracting economy (in a recession or close to it) hit the advertising industry the first and hard – as companies look to cut spending. Advertising is GOOG’s life blood and the management realized that GOOG was a one trick pony and went on a shopping spree to acquire the next “NEW” thing. However, the many “NEW” things they have acquired have yet been turned into revenue generation and until they do – advertising is the main pipe line. If we head into a deeper recession – expect GOOG to see more short-falls. This will affect other ad-revenue dependant companies as well, is MSFT play for YHOO to early?
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Losses and Write-downs from Home Defaults continue
GMAC reports a loss exceeding $700 million in the 4th quarter from the increase defaults in home loans. GMAC has already laid off over 5,000 employees in their mortgage business (Residential Capital) and promised shareholders they would get back to profitability in 2008. While the auto-loan sector remained profitable – (over $200 million in the 4th quarter) it is shrinking significantly and with the mortgage related sector losing $900+ million they are facing an up-hill battle. They have already laid off 1/3 of their work force – expectations are for more job cuts in the 1st and 2nd quarter.
S&P had been lowering their credit rating on a majority of mortgage back securities and have forecast an increase of write downs to exceed $250 billion. Fitch has already down-graded 130,000 bonds and announced this morning that they will be downgrading more bonds and some previously highly coveted AAA rated CDOs (collateralized debt obligations) - structured products dependant on mortgages. Fitch was one of the first to act and cut ratings on $67 billion last November – including some AAA to junk. This next round is expected to downgrade many AAA to D (or Default) – below junk.
State pension funds are going to be forced to sell MORE of their positions as ratings drop and their charter states they may not hold products with lower ratings. However, some State funds have had no choice BUT to hold them as the ratings on some products have dropped from AAA to D and with a DEFAULT rating there is not one to sell them to – thus losses dramatically increase and nothing is recouped.
The housing market and mortgage market is far from over and we should expect to see continued write down and losses – now it is filtering in to state funds (pension funds).
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Europe Slowing
Europe is seeing a slowdown both on the industrial side and consumer spending side – the slowest in 4 years. The reported slowdown is causing concern for the ECB (European Central Bank) that is still concerned about inflation pressure and initial reports indicated that while the Euro sector is cooling off – it is strong enough not to face the plight of a recession that the US is in (or going into).
The ECB has been focusing on their economy more than the US (which is focusing on keeping banks solvent). The ECB inflation rate continues to climb and they have indicated that they do NOT want to cut rates, which will keep the Euro strong against the dollar and is believed to keep inflation at bay. However, the recent data creating some concerned that the slow-down maybe larger than initially thought and if it continues – they MAY cut rates – something they want to avoid. The recent data put serious pressure on the Euro as the dollar rallied by 1%.
On the other-side of the coin inflation has reached a 14 year high (based on 15 nations that report in the EU). Expected growth in the EU is expected to drop below 2% - however the data is still not showing that the EU will face a recession and is still significantly stronger than the US.
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ISM drops below 50! Recession Now?
The ISM index (Institute for Supply Management) – which reflects almost 90% of the economy – dropped to 41.9 – the lowest since October 2001 (from 54.4 the previous month). Many use the ISM to measure inflation as a mode of growth vs. contraction. 50 is the break-even between growth and contraction – the reported drop significantly below 50 is reflecting 90% of the economy is now in a recession - according to economist that utilize the ISM as an indicator of economic health.
The expanding housing slump is far from over and we will continue to see the ISM contract as we try to find a bottom.
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Futures Pre-Open
The futures were slightly down in the early morning with Europe reporting a slowing on both the industrial and consumer spending side and then the market caught a serious right-hook with the ISM dropping way below 50 – sending a ripple effect that we are NOW in a recession and we have not seen the worse. The ARB traders stepped aside and let the futures take the smack down – and are starting to step in to purchase the futures now to leg into the short basket at the opening. The futures are front running the cash after the ISM report by 8-10 points – predicting serious pressure on the market as a whole.
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Support / Resistance
It look like we can’t get off the mat – we headed towards the resistance points but that was short-lived. I mean, MY GOD – the FED cuts 125 basis points and we can NOT get a rally?!?!? That to me – spells this economy is facing serious issues and we are far from getting them solved. Expect more cuts and the market not getting a boost.
INDU 12,500 / 13,000 (I think we will visit the 12,500 level – this is NOT a place to get long – but just a pause support. If we break 12,500 we will continue to 12,000 the fast way. I was hoping that the 125bps cut would of got us up to 13,000 to get short – but no hope there)
NDX 1800 / 1900 (We will probably be at 1800 at the opening – the question – do we HOLD? If you get long here – HEDGE 100% if we don’t hold it WILL be a free fall to 1700)
SPX 1350 / 1400 (We got to 1395 yesterday – as I mentioned a got area to get short. We could test 1350 – if we hold 1350 it will give the narrower indices hope that we may stabilize –otherwise?)
RUT 700 / 750 (The 700 level is a key area for the broader market. Last time we broke we slipped to 650 in a couple of days. We will probably test 700 this week – this is very important area as it clearly shows how the broad market is reacting. It is the health of the market and not reliant on any one sector or stock – unlike the NDX or INDU)
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Conclusion
We did get a rally with the cut, but FAR short of what the market had “HOPED” for – but hope is not part of any strategy. The ISM number, GDP contraction, and job losses are all showing economic measurements of a recession. Couple that with the credit ratings cutting ratings faster than a Gatling-gun and we could see losses expand from just banks to state funds (and pension funds). This could spell serious negative pressure on the economy as a whole.
I think we will be resting those bottoms sooner than I had previously thought – possibly this week – that ISM dropping below 50 is not confidence that we have seen a bottom yet. That is a serious cause of alarm. The dollar did show some strength but is that a short-term knee jerk and is BNP right about strength returning? I personally don’t think so and I think we could see the dollar fall further and this is just a short-term pop.
Keep hedging long positions.
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